Paying Off a Tax Debt Just Got Much, Much Easier

If you owe federal tax debt, it may now be easier to strike a deal to settle your debt for less than the full balance.

Does that mean this program is a slam-dunk for taxpayers who can find the money to settle? Unfortunately, no. The IRS may refuse to accept an Offer In Compromise if it believes the taxpayer has other assets it can seize to pay the debt. (And a lot of things are fair game, including IRAs or home equity.) Nor will the OIC likely be accepted if the taxpayer transferred assets into someone else's name, or if it would be against public policy -- such as settling a tax debt after they convicted the taxpayer of fraud.

And to even apply for an OIC, you must pay a $150 nonrefundable application fee and include 20% of the amount you are proposing to settle with upfront. If the application is not approved, that payment will go to the tax debt.

If the offer is approved, you'll have to pay the agreed-upon amount in no more than five payments over five months. If you need a longer installment plan, you'll have to multiply the amount you have available monthly to pay the IRS by 24 instead of 12, and pay the compromised amount over those 24 months.

"I still think bankruptcy is better than OIC in many cases, but if you have certain civil penalties (such as being responsible for unpaid payroll taxes that can't be discharged), maybe the OIC is good," Heinkel advises.

Finally, if you do pay off your tax debt through an Offer in Compromise, you'll be on what he refers to as "five-year probation." He warns: "For the next five years you must file your taxes on time and pay in full. If you don't, then the deal is off. The IRS keeps all the money you gave and you owe the rest of what you owed, plus whatever you now owe as a result of the new problem."